Macroeconomic Developments Report. March 2021

MARTS
MACROECONOMIC
DEVELOPMENTS
REPORT 2021
MARCH

MACROECONOMIC DEVELOPMENTS REPORT
March 2021
March 2021, No 32
© Latvijas Banka, 2021
The source is to be indicated when reproduced.
Latvijas Banka
K. Valdemāra iela 2A, Riga, LV-1050, Latvia
Tel.: +371 67022300 info@bank.lv
https://www.bank.lv; https://www.macroeconomics.lv

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March 2021
CONTENTS
Contents
Abbreviations 3
Introduction 4
1. External Demand 5
2. Financial Conditions 9
2.1 Decisions of the ECB and other major central banks 9
2.2 Global financial market developments 11
2.3 Financing conditions in the Latvian economy 13
3. Sectoral Development 20
3.1 Manufacturing 20
3.2 Construction and the real estate sector 21
3.3 Trade 22
3.4 Transport 23
4. GDPAnalysis from the Demand Side 24
4.1 Domestic demand 24
4.2 Government consumption 25
4.3 Trade balance 26
5. Labour Market, Costs and Prices 28
6. Conclusions and Forecasts 33
7. Analysis of Scenarios 35
7.1 The government financial support provided during the second wave of
the Covid-19 pandemic and its impact on the economy 35
7.2. Assistance to households with children in times of crisis 37
Additional Information 40
Statistics S1

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March 2021
Abbreviations
AS – joint stock company
CSB – Central Statistical Bureau of Latvia
DSGE model – Dynamic Stochastic General Equilibrium Model
EC – European Commission
ECB – European Central Bank
EONIA – euro overnight index average
EU – European Union
EURIBOR – Euro Interbank Offered Rate
FRS – US Federal Reserve System
GDP – gross domestic product
HICP – Harmonised Index of Consumer Prices
IMF – International Monetary Fund
MFI – monetary financial institution
OPEC – Organization of Petroleum Exporting Countries
OPEC+ – OPEC Member States and the Russian Federation, the Republic of
Azerbaijan, the Kingdom of Bahrain, Brunei Darussalam, the Republic of South
Sudan, the Republic of Kazakhstan, Malaysia, the United Mexican States, the
Sultanate of Oman and the Republic of Sudan
PEPP – Pandemic Emergency Purchase Programme
SEA – State Employment Agency
TLTRO – targeted longer-term refinancing operation
UK – United Kingdom
US – United States of America
VAS – state joint stock company
VAT – value added tax
ABBREVIATIONS

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March 2021
Introduction
In 2020, GDP declined less than expected on account of favourable financial conditions,
government support and various economic agents that were able to adapt to the pandemic
restrictions. Despite the vaccination roll-out leading to significantly higher expectations of
the global economic recovery, the negative impact of the pandemic could still be observed
at the beginning of 2021, and Latvia's GDP, most likely, also declined in the first quarter of
the year. The tightened consumption restrictions and high uncertainty continue to stimulate
the build-up of savings, with the growth rate of deposits standing at a 13-year high. The
risk perception of banks and cautiousness of borrowers hamper the recovery of lending.
Meanwhile, loans for house purchase remain on a moderate upward trend. However, the
GDP growth forecast for 2021 overall was increased to 3.3%. With the number of vaccinated
people growing, in the second half of 2021 the restrictions are expected to be eased and
consumers – to have more opportunities to use their savings accumulated during the crisis.
With the business confidence improving, investment activity will increase as well. Export
expansion is expected to be in line with external demand growth. Moreover, the recovery is
projected to be robust and to continue in 2022 against the backdrop of stronger GDP growth.
While the spread of Covid-19 has complicated the labour market situation, the availability of
government support has helped prevent a steeper increase in the unemployment rate. Wage
growth is supported by a raise of the minimum wage, wage increases for several public
sector occupations as well as Covid-19 pandemic-related premiums.
With the consumer price deflation coming to an end, the rising prices of global commodities
and services will drive consumer prices higher. While inflation is not expected to surge, in
some months of 2021 the year-on-year inflation may temporarily approach the level of 3%.
For 2021 overall, however, Latvijas Banka's inflation forecast has been raised to 1.8%. In
2022, inflation is expected to increase slightly further.
INTRODUCTION

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March 2021
1. EXTERNAL DEMAND
1. External Demand
Last year ended with good news about the efficacy of several developed vaccines, giving
reason to expect that the pandemic will be contained in 2021. Meanwhile, several repeated
Covid-19 outbreaks in different regions of the world, the slow rate of vaccination as well as
new variants of the virus give rise to concerns over the pace of economic recovery.
In its January 2021 forecast, the IMF estimates that the global economy contracted by 3.5%
in 2020. This result is better than projected by the IMF in autumn 2020 as it is based on
a faster recovery in the third quarter of 2020 as well as higher economic resilience over
the following virus outbreaks during which governments introduced much more targeted
measures to contain the spread of the virus. The extensive monetary policy and fiscal policy
support instruments employed by major central banks and governments respectively to
mitigate the consequences of the Covid-19 pandemic crisis, dampened the decline in the
economic activity.
In the view of the IMF, the future progress of economic recovery will vary across countries
depending on the epidemiological situation, the pace of vaccination, the efficiency of the
support measures introduced as well as the structural economic characteristics and the
related cross-border transmission effects. Given these factors, the IMF expects the global
economy to grow by 5.5% and 4.2% in 2021 and 2022 respectively. Compared to the
autumn 2020 forecast, the assessment for 2021 was revised upwards by 0.3 percentage point,
reflecting expectations of an accelerated vaccination roll-out and further strengthening of
the economic activity stimulated by the fiscal support which is provided in major developed
countries. Purchasing Managers' Index increased from 52.5 in September to 53.2 in
February. The improvement in sentiment was primarily driven by a growing number of new
orders as well as rising commodity prices owing to higher demand and overburdened supply
chains. Over the coming months, the deterioration of the epidemiological situation may
become the main obstacle to faster economic recovery.
At the end of the previous year, several downside risks did not materialise and the balance
of risks improved. At the end of 2020, the EU and the UK reached a Trade and Cooperation
Agreement, inter alia providing for zero tariffs and quotas on all goods complying with
the appropriate rules of origin. The agreement significantly improved the EU-UK trade
expectations. The UK Parliament ratified the agreement on 30 December 2020, whereas
the European Parliament intends to ratify it in the first half of 2021. Meanwhile, 2021
started with the US Congress officially confirming the victory of Joe Biden, the Democratic
candidate for the presidential election held in autumn. This gives reason to hope that the US
will improve its trade relationships with its key cooperation partners and participate in the
fight against climate change. Growth expectations for 2021 also improved on account of the
economic stimulus package proposed by US President Joe Biden and approved in March.
The package amounts to 1.9 trillion US dollars, i.e. 8.9% of GDP, constituting the third fiscal
injection into the US economy during the Covid-19 crisis.
Improvements in the economic outlook were also reflected in rising commodity prices.
Looking at the oil market, OPEC+ countries have continued to cut the group's total oil
output by 7.2 million barrels per day, and Saudi Arabia is committed to voluntarily reduce
its oil output by another 1 million barrels per day by April. As a result, in February 2021 the
price of oil per barrel returned to its pre-pandemic level, exceeding 60 US dollars per barrel.
The US economic situation has improved significantly suggesting strong future growth.
Following a record-high growth rate in the third quarter of 2020, which saw a 7.5% increase
quarter-on-quarter, the US economy continued its recovery. In the last quarter of the year,
its growth rate was 1.1% higher than in the previous quarter. The rapid expansion was
largely supported by a rise in investment and private consumption. In 2020 overall, the

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March 2021
US economy contracted by 3.5%. Labour market data point to another improvement. In
February 2021, the unemployment rate declined to 6.2%, while the increase in the number of
jobs significantly exceeded analysts' expectations. Given the rising energy prices as well as
the upward pressure of commodity prices, the US annual inflation reached 1.7% in February.
The rise in inflation has affected the expectations that the monetary policy support measures
could be phased out faster. According to the IMF forecasts, the rate of the US economic
recovery will be 5.1% in 2021 and 2.5% in 2022.
One of the factors leading to a better-than-expected growth rate in the third and fourth
quarters of 2020, was the rapid containment of Covid-19 in China and the following
recovery in global trade. At the end of the year, China already recorded economic growth.
Moreover, in 2020 overall its GDP grew by 2.3%. The Purchasing Managers' Indices
point to slower growth in February 2021. Nevertheless, they suggest strong recovery in
both services and manufacturing sectors. The IMF expects China's economy to grow by
8.1% and 5.6% in 2021 and 2022 respectively. Meanwhile, in the fourth quarter of 2020
Japan's economy was more resilient than initially expected. Its GDP increased by 2.8%
quarter-on-quarter, whereas in 2020 overall it declined by 4.8%. At the same time, given the
growing number of Covid-19 cases as well as the second state of emergency declared by the
government in early January, growth is expected to slow down in the first quarter of 2021. In
the second quarter, however, the economy will start its recovery supported by a significant
government budget approved for this year. According to IMF forecasts, Japan's GDP growth
will be 3.1% and 2.4% in 2021 and 2022 respectively.
In the last quarter of 2020, the euro area economy contracted by 0.7% quarter-on-quarter,
whereas in 2020 overall euro area GDP declined by 6.6%, less than ECB had expected
in its 2020 forecasts (–7.3%). In the second half of 2020, Europe faced repeated waves
of Covid-19 outbreaks. Nonetheless, the experience gained during the first wave allowed
governments to introduce more targeted restrictions which mostly affected the economic
activity in the services and manufacturing sectors. Thus, in the last quarter of 2020 retail
trade shrank by 1.2% quarter-on-quarter. Meanwhile, the output of manufacture recorded
an increase of 3.0%, thereby supporting recovery. According to the Purchasing Managers'
Index, the K-shaped recovery continued in the first two months of 2021 as the sentiment
in the manufacturing sector strengthened, while that in the services sector remained
pessimistic. Owing to the fiscal support, the labour market was resilient against the shocks
of the Covid-19 pandemic crisis. In January 2021, the unemployment rate was 8.1%,
only 0.7 percentage point higher year-on-year. On account of an upward pressure from
external factors as well as increases in the tax rate on carbon dioxide emissions and the
value added tax rate in Germany at the beginning of the year, euro area recorded a rise
in inflation. While the price level was still 0.3% lower year-on-year in December 2020,
it was already 0.9% higher year-on-year in February 2021. Inflation was also driven by
changes in consumer behaviour observed in 2020. According to the March 2021 ECB
staff macroeconomic projections, euro area GDP is expected to grow by 4% in 2021,
almost unchanged from the December 2020 Eurosystem staff macroeconomic projections,
1. EXTERNAL DEMAND
Chart 1
–25
–20
–15
–10
–5
0
5
10
15
20
Q1 Q2 Q3 Q4 Q1 Q2 Q4
2019 2020
–25
–20
–15
–10
–5
0
5
10
15
20
Q3 I
2021
EURO AREA GDP, MANUFACTURING
OUTPUT AND RETAIL TRADE TURNOVER
year-on-year; %)
(
GDP
Manufacturing output (right-hand scale)
Retail trade turnover (right-hand scale)

7
March 2021
1. EXTERNAL DEMAND
representing only a 0.1 percentage point improvement. Meanwhile, according to the March
2021 ECB staff macroeconomic projections for 2022, the euro area economy will grow by
4.1%.
Furthermore, in the last quarter of 2020 and in 2020 overall Latvia's major EU trade partners
continued recording stronger economic growth than the euro area on average.
Following the relatively resilient performance during the crisis, the Baltic States continued
their successful recovery. In 2020, Lithuania and Estonia fared well compared to most EU
countries, with their economies only contracting by 0.8% and 2.9% respectively. The two
largest Latvia's foreign trade partners were among the few EU countries that were able to
expand their exports of goods in 2020. In 2021, the neighbouring countries are expected
to continue their dynamic development, albeit slightly slower than euro area on average.
Germany was also able to record growth in the fourth quarter, despite the structural issues
and supply disruptions in the automotive industry. According to preliminary data, the total
annual decline in Germany's economy was slightly less pronounced than in euro area on
average. Strong fiscal stimulus as well as less stringent restrictions implemented over shorter
time-frames compared to those implemented in other major economies allowed Germany to
slow down the contraction of employment and encouraged renewed consumption of goods.
Furthermore, stronger external demand facilitated the recovery of manufacturing at the
end of the year. However, with Germany's production, including construction, declining by
2.5%, in January the recovery of its manufacturing was delayed, thus weakening Germany's
prospects of starting the year with economic growth. According to the EC forecasts,
Germany will be the first major EU country to reach the pre-crisis level of GDP.
2019
III VI IX XII
Chart 2
Euro area
Germany
Estonia
Latvia
Lithuania
Poland
Sweden
UK 40
80
90
100
110
120
50
60
70
40
80
90
100
110
120
50
60
70
2020
III VI IX XII
2021
ECONOMIC SENTIMENT INDICATORS
(long-term average = 100)
Sweden's economy contracted less than most EU economies in 2020 as it saw a less
pronounced decline in the second quarter and stronger growth in the fourth quarter. At
the turn of the year and in early 2021, the Covid-19 infection rate in Sweden was one
of the highest in the world and, consequently, restrictions were tightened in Sweden.
Nonetheless, for the entire duration of the pandemic and even after their tightening,
Sweden's restrictions remained among the mildest globally. Furthermore, at the beginning
of the year the economic sentiment in Sweden improved further un turned positive owing to
strong industrial confidence. Other economic sectors also suggested expectations of robust
development. According to the EC forecasts, Sweden's economy will grow by 2.7% and
4.0% in 2021 and 2022 respectively.
The UK fared much worse due to the fact that the services sector and the automotive
industry represent a large share in the UK's economy which contracted by 10% in 2020.
Thus, it will take longer for it to rebound to its pre-crisis level. Due to delays associated with
the implementation of the new UK-EU trade regulation, UK's exports suffered a record-steep
decline. This led to the decision to start implementing the new procedure on imports half a
year later, i.e. in 2022, thus reducing obstacles and also improving the outlook of Latvia's
exports to this country.
According to the preliminary data, Russia's GDP declined by 3.1% in 2020. This should

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March 2021
be considered good performance, considering that, apart from the direct impact of the
virus-related restrictions, Russia's economy also suffered from the plummeting oil prices.
Therefore, due to the steep decline in the value of exports, Russia's positive trade balance
deteriorated significantly, whereas private consumption shrank by more than 8%. The fall in
economic activity was cushioned merely by an increase in government spending, envisaged
to be gradually phased out on the back of oil prices which started rising again in 2021.
Assuming that Covid-19 vaccines will be broadly available and the external environment
will improve, the IMF forecasts developed at the beginning of 2021 envisage Russia's
economy to grow by 3.0% and 3.9% in 2021 and 2022 respectively.
1. EXTERNAL DEMAND

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March 2021
2. Financial Conditions
With the risks of the second wave of the pandemic materialising at the turn of the year,
the ECB and the Bank of England decided on further monetary easing, whereas the FRS
and the Bank of Japan chose to preserve the existing highly accommodative monetary
policies. Despite the renewed upsurge in Covid-19 infections and the economic effect of
the associated restrictions, financial markets remained optimistic. The positive sentiment is
largely inspired by the supportive monetary and fiscal policies. Combined with the successful
development and roll-out of the vaccines, this gives reason to expect a return to normal life
in a foreseeable future.
2.1 Decisions of the ECB and other major central banks
Following an assessment of the economic outlook, the Governing Council of the ECB
decided to strengthen the degree of monetary accommodation by increasing the envelope
of the pandemic emergency purchase programme (PEPP) by 500 billion euro and extending
the horizon for purchases by another nine months. The PEPP envelope was increased to a
total of 1850 billion euro, whereas the asset purchases will continue at least until the end of
March 2022. With this decision, the ECB strengthened the market expectations of a strong
monetary policy support to tackle market fragmentation and any disruptions in monetary
policy transmission. At the same time, the ECB confirmed that, with a view to maintaining
favourable financing conditions, the asset purchases within the framework of the PEPP
can be recalibrated as needed, which means that the envelope may not be used in full or it
can be increased if required by the economic and financial conditions. The amount of asset
purchases made at the turn of the year was smaller, and at the end of February almost 47%
of the PEPP envelope were used up. At the same time, at its March meeting, the Governing
Council announced that it expected purchases under the PEPP over the next quarter to be
conducted at a significantly higher pace than during the first months of this year.
The ECB also decided to further recalibrate the conditions of the third series of targeted
longer-term refinancing operations (TLTRO III) by raising the total amount of borrowing
in TLTRO III operations and announcing that it would conduct three additional operations
between June and December 2021. The period over which considerably more favourable
terms will apply was also extended by twelve months (until June 2022). The especially
favourable TLTRO III borrowing conditions will be made available only to credit institutions
that achieve the corporate and household lending performance targets. The terms of the
traditional asset purchase programme (APP) and the key ECB interest rates remained
unchanged over the reporting period.
Chart 3
Prior to COVID-19 crisis (February 2020)
Prior to PEPP announcement (March 2020)
March 2021
September 2020 –0.75
–0.50
–0.25
0.00
MARKET-IMPLIED PATH OF THE ECB'S
DEPOSIT FACILITY RATE
(%)
–0.75
–0.50
–0.25
0.00
2020 2021 2022 2023 2024 2025
IX III IX III IX III IX III IX III IX
III
Christine Lagarde, President of the ECB, has pointed out that economic developments
continue to be uneven across countries and sectors, with the services sector being more
adversely affected by the restrictions on social interaction and mobility than the industrial
sector, which is recovering more quickly. Looking ahead, the ongoing vaccination
campaigns together with the gradual relaxation of containment measures – barring any
2. FINANCIAL CONDITIONS

10
March 2021
further adverse developments related to the pandemic – underpin the expectation of a firm
rebound in economic activity in the course of 2021. Overall, the ECB continues to stress that
the financing conditions should remain favourable, in order to ensure the convergence of
inflation to the ECB's medium-term target of below, but close to, 2%. President of the ECB
also pointed out that the risks surrounding the euro area growth outlook over the medium
term have become more balanced, although downside risks remain in the near term. Better
prospects for the euro area's external demand, bolstered by the sizeable fiscal stimulus, and
the progress in vaccination campaigns are encouraging. Nevertheless, the ongoing pandemic,
including the spread of virus mutations, and its implications for economic and financial
conditions continue to be sources of downside risk.
Chart 4
EONIA
3-month EURIBOR
6-month EURIBOR
12-month EURIBOR
–0.40
–0.30
–0.20
–0.10
0.00
–0.60
III VI IX XII
2019
III
2020
–0.50
–0.40
–0.30
–0.20
–0.10
0.00
–0.60
–0.50
VI IX XII
2021
EURO MONEY MARKET RATES
( )
%
Financial markets do not expect any changes in the key ECB interest rates earlier than in
2023.
At the beginning of autumn, the FRS announced a change to its monetary policy goal. The
FRS is mandated to achieve maximum employment and longer-term inflation of 2%. With
inflation running persistently below its longer-run goal, it was judged appropriate to aim to
achieve inflation moderately above 2% for some time so that to support the anchoring of
longer-term inflation expectations. Although the target range for the federal funds rate has
been left unchanged at 0.00%–0.25% since September, the FRS has enhanced its forward
guidance by stating that it expects to maintain the target range at the existing level until
labour market conditions have reached levels consistent with the FRS's assessments of
maximum employment and inflation has reached the new target. At the same time, the
FRS also continues its asset purchase programmes by increasing its holdings of both US
Treasury securities and agency mortgage-backed securities at a monthly pace of 120 billion
US dollars. The US economic forecast published by the FRS in December was revised
upwards in comparison with the September forecast. Nevertheless, at the end of January,
the FRS already admitted that the economic recovery was decelerating under the impact of
the second wave of the COVID-19 pandemic. At the same time, the inflation expectations
priced in by the US financial markets have risen and have sparked discussions among
analysts as to whether the FRS should perhaps start signalling that it might reduce the
stimulus. Nevertheless, Jerome Powell, the Chair of the FRS has announced that, at the
current juncture, any talks about tapering would be premature. Over the most recent months,
the rise in inflation expectations priced in by the financial markets is largely associated with
the enormous US fiscal policy support. Consistent with higher inflation expectations, the
financial markets also expect an earlier rise in the FRS interest rates (at the turn of 2023),
contrary to the FRS guidance that the target range will remain unchanged in a foreseeable
future.
Like the ECB, in face of a renewed rapid increase in Covid-19 infections, the Bank of
England also decided to increase the target stock of purchased UK government bonds by
an additional 150 billion British pounds sterling, thereby taking the cumulative amount of
quantitative easing to 895 million British pounds sterling. At the same time, the Bank Rate
was maintained at 0.1%. The Bank of England has been considering a negative Bank Rate

11
March 2021
for quite some time. Although steps have been taken to prepare for the implementation of
a negative Bank Rate, at its February meeting, the Bank of England maintained that this is
not a signal about the likelihood or imminence of a negative rate and a further analysis as
to the potential effect of such a rate on its targets is required. As at the end of February, the
financial markets no longer priced a negative Bank Rate in the future.
Chart 5
–0.2
0.0
0.6
1.0
US ( )
20
September 20
UK ( )
20
September 20
( )
20
Japan September 20
US ( )
21
March 20
UK ( )
21
March 20
( )
21
Japan March 20
0.4
0.2
2021 2022
2020 2023
0.8
–0.2
0.0
0.6
1.0
0.4
0.2
0.8
MARKET CENTRAL BANK
IMPLIED
POLICY RATES
( )
%
The Bank of Japan has implemented no changes in its monetary policy since the beginning
of September. The Bank of Japan is maintaining the short-term policy interest rate at –0.1%
and the target level of 10-year government bond yields at around 0.0%. As to the asset
purchases, the Bank of Japan indicates that it will preserve the current pace of purchases as
long as it is necessary for achieving and maintaining the inflation target of 2% in a stable
manner. The Bank of Japan is still reporting its readiness to take additional easing measures,
if necessary, and it also expects short-term and long-term policy interest rates to remain at
their present or lower levels. Financial markets do not price in any changes in the Bank of
Japan's policy rates in a foreseeable future. At the same time, the Bank of Japan has launched
a monetary policy strategy review, scheduled for completion in March 2021.
2.2 Global financial market developments
From the beginning of September 2020 to the end of January 2021, the sovereign bond
markets of developed economies were relatively calm, but later, with the incoming news
of the expected sizeable fiscal stimulus, inflation expectations in the United States started
to rise steadily, triggering a sell-off of longer-term US Treasury bonds. Mirroring the
developments in the United States, the yields of longer-term euro area government bonds
also started to rise. From the beginning of September 2020 to 10 March 2021, the yield on
the German 10-year government bonds has increased by 12 basis points, whereas the yield
of the respective maturity US Treasury bonds grew by 89 basis points. Initially, the euro
area government bond yields co-moved with the yields on the US Treasury bonds, but in the
first week of March their movement reversed. The decline of the euro area government bond
yields in the first week of March can be explained by the publicly-expressed concerns of the
ECB executives about the tightening of the financial conditions and the subsequent ECB's
decision, over the next quarter, to conduct purchases under the PEPP at a significantly higher
pace than during the first two months of the year. This decision of the Governing Council of
the ECB made market analysts realise that any expectations of a steeper rise in the euro area
yields would be premature. An analysis of the spreads between benchmark bonds (German
government bonds) and other euro area government bonds leads to a conclusion that the
country-specific risks have decreased in the reporting period. Italy, where the yields on
10-year government bonds have decreased by 35 basis points since September, to stand at
0.68% on 10 March, is worth a special mention. There has been a change of the government
in Italy in the reporting period, with Mario Draghi, the former President of the ECB,
becoming the new Prime Minister, and this makes financial markets confident that the Italian
government is set on the course to implement the highly required reforms. At euro area
government debt securities auctions, bids for new issues still more than exceed the supply.
Over the coming months, the yields on euro area government debt securities will continue to

12
March 2021
be largely affected by inflation expectations as well as the ECB's monetary policy. As long as
the medium-term inflation does not sustainably converge with the level of 2%, the ECB can
be expected to prevent any tightening of the financing conditions.
The spreads of the euro area corporate bonds relative to benchmarks have continued to
narrow. The largest decrease in yields was reported specifically for high-yield debt securities.
In the circumstances of continued fiscal measures implemented by governments to support
economic activity and particularly favourable financing conditions maintained by central
banks, investors continue to search for higher yields. The number of companies defaulting
on their liabilities to the holders of their debt securities remains low. At the same time, new
issues have primarily increased in the high-yield debt securities segment since the beginning
of the year, suggesting that companies enjoy access to market financing and investors are
optimistic about the future prospects. Further development of corporate bond yields will
largely depend on the speed of containing the pandemic and successful restoration of the
economic activity.
Since the beginning of September, stock markets in both the euro area and the United States
exhibited individual brief episodes of higher volatility, as suggested by VSTOXX and VIX
indices. The first episode of elevated volatility was observed at the end of October, with
the emergence of the first news of the second wave of the pandemic, accompanied by the
uncertainty surrounding the outcome of the US Presidential elections. The second episode
was registered at the end of January, caused by concerns about new coronavirus strains and
the slow progress with vaccine roll-out, whereas the third episode was observed at the end
of February which coincided with financial markets pricing in the 1.9 trillion US dollar
worth economic recovery plan of the US President Joe Biden. Inflation expectations rose
steadily in anticipation of the fiscal stimulus in the United States, followed by an increase
in longer-term US Treasury bond yields, prompting investors to adjust their debt portfolios
accordingly. In each of those episodes, both EuroStoxx 600 characterising the European
stock market and S&P 500 characterising the US stock market temporarily decreased.
Nevertheless, in the whole period from the beginning of September 2020 to 10 March 2021,
EuroStoxx 600 and S&P 500 appreciated by 17% and 10% respectively. A more impressive
rise in the case of European stocks can be primarily explained by weaker previous growth.
Looking at stock performance across European countries, better results as compared to
the German Stock Index DAX were achieved by the French CAC 40, Italian FTSE MIB
and Spanish IBEX 35 indices, appreciating by 12%, 21%, 22% and 23% respectively.
Overall, the stock markets both in Europe and the United States are still largely affected by
market sentiment, yet corporate earnings are also higher than projected by analysts in most
cases. The role of market sentiment as the driver of stock prices is also confirmed by the
previously-mentioned brief volatility surges, where adjustments were usually followed by
steeper spikes. At the beginning of November, stock prices started climbing steadily against
the background of the successful vaccine testing news, whereas at the beginning of February
the market sentiment was improved by expectations of a more sizeable than expected fiscal
stimulus in the United States as well as, in general, by the strengthening of the confidence
that, with the vaccine roll-out proceeding smoothly, the pandemic could be contained in
a foreseeable future. The last adjustment at the end of February was delayed by central
bank signals, particularly the remark of the Chair of the FRS that any talk about monetary
tightening is premature. Looking by sector, since the positive news about the vaccine testing,
the largest improvements in stock prices were reported for cyclical sectors that were hit
the hardest at the onset of the pandemic. Going forward, the stock market developments
will significantly depend on the progress with vaccination and further containment of the
pandemic. While vaccination is still only gathering pace, the key role will be played by the
ongoing central bank support to favourable financing conditions.
From the beginning of September 2020 to 10 March 2021, the euro depreciated by 0.4%

13
March 2021
0.4% against the US dollar (to 1.188 US dollars per euro). There was some volatility
throughout the period, with the exchange rate peaking at the turn of 2020, when it climbed
above 1.23 US dollars per euro for a short time. The appreciation of the euro against the
US dollar observed in the autumn months was related to the general weakening of the
US dollar against a broader basket of currencies. This was initially sparked by both the FRS
announcement at the beginning of autumn of a change to a medium-term inflation objective
and the uncertainty about the outcome of the US Presidential election, an additional factor
being the successful vaccine development, causing a shift in cash flows to riskier assets.
At the same, the historical relative attractiveness of interest rates, which swiftly changed in
favour of the euro at the onset of the pandemic, continued to put an upward pressure on the
euro. EU-UK Trade and Cooperation Agreement, signed at the turn of the year, also was
positive news for the euro. The subsequent depreciation of the euro was related to both the
expected sizeable fiscal stimulus in the United States and the relatively slow vaccine roll-
out in the euro area as compared to the United States. Going forward, analysts have reduced
their expectations of the euro's appreciation vis-à-vis the US dollar in comparison with what
was projected in the autumn months. At the same time, they also do not anticipate a major
weakening of the euro. Such an assessment is based on concerns that the economic recovery
in the euro area will take longer than that in the United States, and this will also be reflected
in the central bank decisions. In the coming months, the movement of the euro exchange
rate against the US dollar will largely depend on successful and quick containment of the
pandemic in the euro area, with the key factor being the pace of vaccination.
EUR/USD
EUR/USD (forecast; March 2021) 1.00
1.05
1.10
1.15
1.20
1.25
2019
Chart 6
EURO EXCHANGE RATE AGAINST US
DOLLAR AND FUTURE EXPECTATIONS
2020
III VI IX XII VI
III VI IX XII
2021
1.00
1.05
1.10
1.15
1.20
1.25
III
2.3 Financing conditions in the Latvian economy
Despite the second wave of the Covid-19 pandemic, Latvia's credit ratings remained
unchanged, and the financial conditions remained favourable. The tight restrictions and
deterioration of the business and consumer confidence continue to stimulate the build-
up of forced and precautionary savings, maintaining a high growth rate of deposits with
credit institutions. Lending recovery was dampened by a higher risk perception of banks
upon expiry of the moratoriums on fulfilment of obligations and cautiousness in investment
decisions. Overall, the financing conditions for households and businesses did not
deteriorate significantly. A positive surprise was the housing market's adjustment to the new
circumstances: despite the high uncertainty caused by the Covid-19 crisis, the demand for
new loans increased, while the respective interest rates were reduced.
Given the pandemic and negative sentiment, the decline in the loan portfolios of non-
financial corporations and households should be considered moderate. Thanks to the
accommodative monetary policy and bank relief measures to businesses working in the
sectors suffering the most from the crisis, from December 2020 to February 2021, the
amount of outstanding loans shrank by a mere 1.6%, with corporate loans experiencing
a somewhat larger decline and household loans remaining broadly unchanged. Loans for
house purchase remained unscathed by the crisis and did not suffer from a weaker demand
either, increasing by 1.0% during the same period. The ratio of loans to GDP remained at

14
March 2021
the level of 38% in 2020. The aggregate domestic loan portfolio expanded significantly in
January 2021 on account of a one-off factor, i.e. a credit institution purchasing a leasing
company and refinancing its debt. As a consequence, the domestic loan portfolio (including
loans to financial institutions) increased by 4.3%. This also formally brought the annual rate
of change in domestic loans to a positive territory (3.9% in February), although, looking past
the impact of the structural changes in the banking sector, reclassification of the institutional
sectors and one-off factors, the rates remained negative at –1.4% for aggregate loans, –2.2%
for loans to non-financial corporations and –0.2% for household loans. Some stabilisation
in lending was signalled by a rebound in new corporate loans and household loans from
the previous low levels. Over the six months from September 2020 to February 2021, new
loans increased by 16.3% in comparison with the previous six-month period from March
to August 2020 (an increase by 22.4% and 11.4% in the case of household loans and loans
to non-financial corporations respectively). Along with the decline in lending by credit
institutions, loans by non-bank financial institutions also contracted at an overall annual rate
of 6.0% in December 2020, including 7.1% in the case of loans by leasing companies.
Chart 7
Total (excluding government)
Financial institutions and non-financial
corporations
Households 0
80
120
60
40
20
100
0
80
120
60
40
20
100
Q3 Q4
2020
Q1 Q2
2006 2008 2010 2012 2014 2016 2018
DOMESTIC LOANS
)
(outstanding amounts at the end of period; % of GDP
Chart 8
DOMESTIC LOANS
(outstanding amounts; annual percentage changes*)
Non-financial corporations and households
Non-financial corporations
Households
Leasing companies –8
0
4
8
* Excluding the effect of credit institution sector restructuring.
2019
III IX XII
2020
III IX
2021
–6
VI VI
2
–4
–2
6
–8
0
4
8
–6
2
–4
–2
6
XII
As expected, the development of interest rates on loans to non-financial corporations was
shaped by counteracting factors in the reporting period. After the first wave of the Covid-19
pandemic, the rates returned to the pre-crisis levels, followed by an increase when the
second wave of the pandemic started gathering strength. On the one hand, the economic
turbulences caused by the Covid-19 pandemic resulted in a higher credit risk of loans to non-
financial corporations. Some significant credit institutions maintained tight credit standards
in the reporting period and granted relatively little loans to non-financial corporations even
at higher interest rates. Although according to the euro area bank lending survey responses,
one of the surveyed Latvian credit institutions eased the credit standards on loans to non-
financial corporations in the third quarter of 2020, this did not contribute to the return of
the credit standards to the levels seen before the Covid-19 crisis. As a consequence, smaller
credit institutions, traditionally granting riskier loans at a higher price, managed to increase
their share in the new lending flows. With the moratorium concerning a universal approach
of credit institutions to granting grace periods to loan repayments expiring in September, the
proportion of renegotiated loans in new loans to non-financial corporations started to grow.
Some credit institutions increased both the amount of renegotiated loans as well as their

15
March 2021
interest rates at the turn of the year, signalling that non-financial corporations have managed
to renegotiate the terms of their existing loans. At the same time, an even higher rise in
the interest rates on loans to non-financial corporations was prevented by the continuously
high degree of monetary accommodation provided by the ECB, the support to businesses
affected by the Covid-19 crisis provided by AS Attīstības finanšu institūcija Altum and
other government support measures as well as the credit institutions' attempts to reduce the
credit risk by requiring a larger collateral. From August 2020 to January 2021, the interest
rate on new euro loans to non-financial corporations ranged from 2.7% to 3.7%, overall
increasing by 0.2 percentage point (from 2.8% in July 2020 to 3.0% in January 2021). A
higher credit risk premium can be expected to be priced in the interest rates of loans to non-
financial corporations also in 2021, but it could decrease with the start of economic recovery
following the Covid-19 crisis, improvement in the financial position of non-financial
corporations and review of credit standards in some Latvian credit institutions.
A positive surprise in the period from August 2020 to January 2021 was the decline in the
interest rate on loans for house purchase. The main reason behind the decrease was the
effect from the AS Attīstības finanšu institūcija Altum housing guarantee programme, a rise
in the share of collateralised loans and an improvement in the financial situation of some
credit institutions. Overall, since July 2020, the interest rate on new euro loans to domestic
households for house purchase decreased by 0.6 percentage point (2.4% in January 2021). In
the second half of 2020, despite the Covid-19 crisis, household demand for loans for house
purchase increased, as reported by two out of four Latvian credit institutions participating
in the ECB's euro area bank lending survey. The credit institutions explained this change by
the growing consumer confidence, housing market development and low level of interest
rates. Another contributing factor could be the broadening of lending opportunities available
to young families from the AS Attīstības finanšu institūcija Altum housing guarantee
programme. With the demand growing, the amount of housing loans granted on the basis
of new lending agreements increased in the second half of 2020. As the loans for house
purchase were mostly secured by guarantees, they carried a lower interest rate and, with
their share in the lending flows growing, the respective weighted average interest rate
also declined. Moreover, according to the euro area bank lending survey, one out of four
respondent Latvian credit institutions reduced its margin on loans to households for house
purchase in the fourth quarter of 2020 on account of improved cost of funds and balance
sheet constraints. In the first half of 2020, credit institutions also most often granted 1-year
loan repayment holidays to households; therefore, the interest rates on housing loans do not
reflect the real increase in household credit risk. Over the next half of the year, the interest
rates on loans for house purchase will continue to be affected by the depth and duration
of the Covid-19 crisis, as, with the loan repayment holidays and moratorium expiring, the
quality of the previously-granted loans for house purchase could deteriorate and banks may
have to revise upwards the lending rates in this segment.
Chart 9
III VI IX
Loans to households for house purchase
Other lending to households
Loans to non-financial corporations
Total loans
Consumer credit (right-hand scale)
XII III VI IX XII
0
5
10
15
20
25
0.0
1.5
3.0
4.5
6.0
7.5
2019 2020 2021
WEIGHTED AVERAGE INTEREST RATE ON
NEW LOANS BY TYPE OF LOAN
(%)
Consumer credit rates remained volatile. Nevertheless, some credit institutions slightly
eased their terms and offered consumer credit at lower interest rates, particularly in the last
quarter of 2020. The interest rate on new consumer credit and other lending to households

16
March 2021
in euro ranged from 9.6% to 11.9% in the reporting period. One of the four respondent
Latvia's credit institutions admitted in the euro area bank lending survey that margins on
consumer credit and other lending to households were reduced in the fourth quarter of 2020
on account of lower cost of funds and balance sheet constraints. Overall, the demand for
consumer credit declined from August 2020 to January 2021, as suggested by a smaller
amount of consumer credit and other lending to households granted on the basis of new loan
agreements.
The protracted pandemic had a negative effect on the willingness and opportunities of
spending and investment in both household and non-financial corporation sectors. At the
same time, the solid export performance, rising wages, relatively low unemployment growth
as well as the fact that several sectors escaped the negative impact of the crisis contributed
to a solid build-up of savings on accounts with credit institutions. In February, the annual
growth rate of domestic deposits reached 16.1%, the highest level since 2007. Deposits by
both households and non-financial corporations expanded rapidly, with the annual growth
rates in February standing at 14.9% and 16.7% respectively. From September 2020 to
February 2021, domestic deposits with credit institutions overall increased by 1.2 billion
euro or 8.9%, including a 662 million euro or 8.2% and a 450 million euro or 9.3% rise in
the case of household deposits and deposits by non-financial corporations respectively.
Chart 10
Tightened credit standards
emand for loans
D –100
0
100
–25
–75
25
50
75
–50
–100
0
100
–25
–75
25
50
75
–50
2020
2019
CHANGES IN CREDIT STANDARDS AND
DEMAND FOR LOANS TO NON-FINANCIAL
CORPORATIONS
( )
net changes; % of surveyed Latvia's credit institutions
1 3 4 1
2 3 4
2
Chart 11
Deposits by non-financial corporations
Deposits by households
2
6
10
18
2020
2019
III VI IX XII III VI
0
4
8
12
2021
14
16
2
6
10
18
0
4
8
12
14
16
IX XII
DOMESTIC DEPOSITS
(annual rate of change; %)
The cost of funds of Latvia's credit institutions on the domestic deposit market remained
low. The interest rate on balances of euro deposits by domestic non-financial corporations
and households, the same as the rate on new fixed term deposits, was close to 0% in the
second half of 2020 and January 2021. Deposit rates remained low supported by the
accommodative monetary policy of the ECB. A downward impact on deposit rates was
also exerted by the changes in saving behaviour of households caused by the Covid-19
pandemic: the build-up of forced savings due to restrictions and precautionary savings due
to uncertainty. With credit institution access to financing improving considerably, the need
to compete for additional funding on the domestic deposit market and offer more favourable
terms and conditions decreased. Moreover, the savings of households and non-financial
corporations accumulated during the Covid-19 pandemic were mostly placed in demand
deposits which are easier accessible but less profitable. The low level of deposit rates for
Latvia's credit institutions enables credit institutions to offer domestic households and

17
March 2021
non-financial corporations loans at more favourable terms and conditions; nevertheless, in
the circumstances of the Covid-19 crisis the key role is played by the lending policy changes
implemented by the banks themselves, state support for loan guarantees as well as the level
of borrowers' risk.
With the epidemiological situation in Latvia and its trade partners gradually improving,
the growth of deposits by non-financial corporations could accelerate and the increase in
private savings could slow down. Any noteworthy recovery in lending in the near term is
unlikely, given the persisting risks to further economic development, the risk perception of
credit institutions as the moratorium on fulfilment of obligations expires, negative economic
sentiment and caution in investment decisions. Loan demand could shrink on account of
loans being replaced by the funding available from the government support measures for
sectors affected by the Covid-19 crisis, whereas household deposits could be temporarily
pushed up by support to families with children and the allowance to pensioners, the disabled
and persons who have lost their supporter, designated to reduce the negative impact of the
Covid-19 spread.
Chart 12
0.0
0.2
0.4
0.6
0.8
2019
III VI IX XII III VI IX XII
2021
0
2
4
6
10
2020
8
Weighted average interest rate on euro deposits
Weighted average interest rate on new euro
deposits by non-financial corporations
Weighted average interest rate on new euro
deposits by households
Share of fixed-term euro deposits in total
deposits by non-financial corporations and
households (right-hand scale)
INTEREST RATES ON DOMESTIC DEPOSITS
AND SHARE OF FIXED-TERM EURO
DEPOSITS
(%)
The international rating agency Fitch Ratings affirmed Latvia's long-term local currency and
foreign currency issuer default rating at the previous A– level, revising the outlook from
negative to stable. Fitch Ratings pointed out the limited effect of the Covid-19 outbreak on
Latvia's economy and public finances due to effective and timely support measures to reduce
the fallout from the Covid-19 outbreak as well as the resilience of Latvia's economy to
external shocks. In January, the Japanese credit rating agency R&I affirmed Latvia's foreign
currency issuer rating at A with a stable outlook. Regardless of the negative impact of the
Covid-19 pandemic resulting in a sharp contraction of the Latvian economy, the economy's
growth fundamentals remain intact so that the economy is likely to return to its growth
trajectory once the pandemic settles down. In February, the international rating agency S&P
Global Ratings raised Latvia's credit ratings to A+, maintaining a stable outlook on the
economy.
Since September 2020, the Latvian government is placing its securities that were previously
released on international markets on the domestic market (same ISIN for securities launched
on both the domestic and international markets). The above securities were scheduled to
mature in 2025, 2026 and 2027. In October, the average yield on bonds maturing in 2026
was –0.33%, whereas in February the average yield on bonds maturing in 2028 was –0.25%.
The advantage of the above issues is that there is already quite a large amount of those bonds
in circulation, they are highly liquid and are eligible for the use in the Eurosystem's asset
purchase operations.
On the secondary market, the average yield on Latvian government bonds maturing in 2028
remained broadly unchanged, moving from –0.20% on 1 September 2020 to –0.19% on
9 March 2021. The high degree of monetary accommodation provided by the ECB supported
a further decline in the yields on government securities, while higher global inflation
expectations over the most recent months and contributed to an increase in those yields. The

18
March 2021
spread vis-à-vis corresponding maturity German government bonds narrowed from 36 basis
points to 26 basis points, similar as in other euro area countries.
Chart 13
–0.50
0.00
0.25
0.50
0.75
1.00
1.25
0
50
100
150
200
250
350
300
2019
2020
–0.25
2021
Supply
Demand
Sold
2-year bond yield (%; right-hand scale)
5–7-year bond yield (%; right-hand scale)
AUCTIONS OF GOVERNMENT SECURITIES
(millions of euro)
In December, Luminor Bank AS issued 300 million euro worth bonds on the Baltic private
sector securities market, with a simultaneous buy-back in the amount of 250 million euro.
The new bonds were with a 4-year maturity and the average coupon rate of 0.792% In
February, AS mogo issued bonds in the amount of 30 million euro, also partly rolling over
the previous bond issues; the maturity of the bonds was 3 years and the coupon rate was
11%.
At the same time, AS GRINDEKS decided on delisting the company's shares and submitted
a share repurchase proposal. Thus, 19 February was the last day when those shares were
listed on stock exchange, and from 1 September 2020 to 9 March 2021 their capitalisation
decreased by 15.2% (to 770.3 million euro). AS VALMIERAS STIKLA ŠĶIEDRA and AS
Rīgas juvelierizstrādājumu rūpnīca also intend to delist their shares.
From 1 September 2020 to 9 March 2021, Latvia's share index OMXR and the Baltic
share index OMXBBGI grew by 0.5% and 23.4% respectively. The share prices of Latvian
companies changed significantly. The shares of AS MADARA Cosmetics and AS SAF
TEHNIKA appreciated by 108.2% and 63.0% respectively, whereas the shares of AS
GRINDEKS and AS Valmieras stikla šķiedra depreciated by 36.6% and 40.7% respectively;
the latter sold its controlling stake to Duke I S. à r.l. registered in Luxembourg. The largest
turnover in the period was reported for the shares of AS Olainfarm (2.9 million euro) and AS
MADARA Cosmetics (0.9 million euro).
The FCMC presented a 10-step programme for the development of Latvia's capital market.
The most important steps in the programme are investment of the state-funded pension
scheme assets in Latvia's capital market, provision of qualitative information to issuers,
promotion of passive investment and protection of investor interests. Finance Latvia
Association presented a 15-point sectoral plan to facilitate access to funding for business
development. The plan is focussed on four key areas: lending, capital market development,
financial literacy and sustainable finance.
Chart 14
0
150
300
France
Spain
Italy
Latvia
100
50
250
200
2019
2021
0
150
300
100
50
250
200
2020
7 YEAR GOVERNMENT BOND SPREADS
RELATIVE TO GERMAN GOVERNMENT
BOND YIELDS
( )
basis points

19
March 2021
AS Attīstības finanšu institūcija Altum established its Investment Fund with an objective of
supporting well-managed and promising businesses in temporary difficulties because of the
Covid-19 crisis as well as developing the capital market. The total amount of the Fund is
100 million euro, and half of it consists of state financing, whereas the other half is private
pension fund investments. The Fund can invest in a company's capital, grant loans as well as
invest in corporate bonds. In February, the Fund completed the first transaction by purchasing
AS ELKO GRUPA bonds in the amount of 2.9 million euro.

20
March 2021
3. SECTORAL DEVELOPMENT
3. Sectoral Development1
At the end of 2020, with the spread of COVID-19 intensifying, the gradually increasing
impact of social restrictions was offset by the ability of both businesses and consumers to
adapt to teleworking as well as by other one-off and temporary factors, e.g. in agriculture
and wood industry. Economic sectors recorded diverging growth: performance of industrial
sectors was good, particularly that of the export-oriented ones, but contribution of several
services sectors was adversely affected by the reinforcement of the COVID-19 pandemic
containment measures.
Chart 15
–10
2
–2
4
8
1 3 4 1
2019
2
0
–4
–6
–8
3 4
2
2020
6
–10
2
–2
4
8
0
–4
–6
–8
6
Year-on-year
Quarter-on-quarter
GDP
( )
at constant prices; %
The economic situation in the second half of 2020 was better than projected, and the effects
of the newly announced state of emergency were not yet reflected in GDP contraction in the
fourth quarter (GDP increased by 1.1% quarter-on-quarter). Opportunities for businesses to
provide full-value services remotely are very divergent across sectors. Therefore, against
the backdrop of the overall economic growth, the accommodation and food services as well
as the recreational and cultural services sectors suffered from the recurrent contraction of
economic activity already in the fourth quarter. Despite the government support and the
population's opportunities to use their savings following the easing of restrictions, some of
the capacity of the above sectors could be lost in case the pandemic lasts longer. Therefore,
their return to the pre-crisis level could be slower than in the economy on average.
3.1 Manufacturing
Irrespective of restrictions and the rapid spread of COVID-19, contribution from
manufacturing was far better than projected. This was largely due to a significant
contribution from the wood industry. Compared to the third quarter, which enjoyed relatively
summery weather and was less affected by COVID-19, the sector's value added increased by
4.2% in the fourth quarter and picked up by 4.0% year-on-year. However, the performance
in the first quarter of 2021 is expected to be weaker. It has already been marked by the
contracting output in manufacturing observed in January.
In the fourth quarter and in 2020 as a whole, manufacturing growth was notably affected by
wood industry, which enjoyed favourable price and demand conditions and had also suffered
less from insect damage in Latvian forests and those of Europe in general. At the same time,
the impact of the pandemic was also evident as the restrictions and teleworking facilitated
the popularity of the do-it-yourself segment. Many rushed to improve their homes with new
floorings, cabinets, saunas and other practical and recreational elements.
The fourth quarter was also successful for manufacture of electrical and other equipment,
printing, manufacture of rubber and plastic products and manufacture of parts for motor
vehicles as well as for the sectors whose data are not disclosed for reasons of confidentiality
(i.e. manufacture of pharmaceutical products, manufacture of computer and electronic
1
This chapter analyses GDP and sectoral data at constant prices, using seasonally and calendar adjusted data (unless
otherwise specified).

21
March 2021
products and/or manufacture of other transport equipment). The year-end proved less
successful for producers of food products and for the sector of repair and installation of
machinery and equipment.
Unfortunately, the year 2021 has started with new problems to contend with, and there are
reasonable grounds to project that manufacturing output will nevertheless edge down in
the first quarter. The industrial confidence indicator is gradually deteriorating. Moreover,
this is also the case in the sectors that delivered growth in the previous quarter. Preliminary
statistical indicators for manufacturing output in January already mark a fall in the monthly
rate of change (1.7%). The annual growth rate nonetheless remains positive (2.8%), but it is
twice as low as it was in the preceding months. In business surveys, producers, more often
than a year ago, point out the need to address other problems constituting a barrier to their
activity (most of these problems are probably related to the availability of logistics as well as
raw materials and components). However, the problem of labour availability has diminished
considerably. Meanwhile, according to businesses, insufficient demand has already been one
of the most significant barriers since mid-2019.
Chart 16
Year-on-year
Quarter-on-quarter –8
2
–2
4
6
0
–4
–6
–8
2
–2
4
6
0
–4
–6
1 3 4 1
2019
2 3 4
2
2020
MANUFACTURING OUTPUT
(at constant prices; %)
3.2 Construction and the real estate sector
Additional funding for road repairs allocated by the government in spring enabled the
construction sector to boost growth at the end of the year, following a weaker performance
in the second and third quarters, i.e. the value added in the fourth quarter increased by
6.5% quarter-on-quarter (by 2.0% year-on-year). It was construction of roads that ensured
construction growth at the end of the year and in 2020 as a whole (3.4%). Construction
of buildings (agricultural non-residential outbuildings, apartment blocks and offices)
and specialised construction activities also followed an upward path. Meanwhile, the
construction of commercial and production buildings as well as utility infrastructure
facilities declined.
The construction confidence indicator remains stable and negative primarily due to the order
assessment, since private investors fear uncertainties of the future. This can prevent new
private buildings from being placed on the market. Inflows of additional investment in the
sector have not introduced adjustments to construction costs, and the annual growth rate
of the overall costs continued to decelerate. This was mainly a result of a drop in building
material prices and deceleration in the growth rate of builders' wages. The rising number
of new buildings at the end of the year observed both in the residential and non-residential
building segments as well as the number of issued building permits suggest that moderate
construction activities are ongoing in all segments. The growth in construction of buildings
will be driven by the need to renew the existing housing stock. The effect of the second wave
of the COVID-19 pandemic and the related restrictions on the construction sector's growth
has been immaterial. However, against the backdrop of uncertain economic development,
the implementation of some private investment projects has been postponed and, with the
cost risk increasing, their implementation at the planned level might be jeopardised, thus
preventing the sector's growth in the medium term.

22
March 2021
In 2020, the value added of the real estate market sector remained almost at the level of
2019 (–0.4%). Following the sharp decrease in the real estate market activity during the
first wave of the pandemic, the second half of 2020 saw it recover. In the fourth quarter, the
value added of the real estate sector rose by 0.2% quarter-on-quarter and by 4.0% year-on-
year. After the first wave of the pandemic, the recovery of the above sector was driven by
a higher demand for real estate located outside Riga as well as by a considerable expansion
of the state support programme for house purchase, including the subsidies programme for
house purchase for families with several children, but at the end of the year the number of
transactions in the real estate market of Riga also moved up, including transactions with
standard apartments. The pandemic has had a greater effect on the number of transactions,
but prices have been less affected. In 2020, prices of standard apartments dropped by 1.5%
on average, but the number of the real estate purchases registered with the Land Register in
Latvia (including Riga) picked up by 2% (by 8% in Riga) compared to 2019.
Chart 17
Buildings
Civil engineering
Specialised construction works
Total –20
–15
–10
–5
0
5
25
20
15
10
–20
–15
–10
–5
0
5
25
20
15
10
1 3 4 1
2019
2 3 4
2
2020
CONSTRUCTION OUTPUT
(at constant prices; quarter-on-quarter; %)
Prudent growth is expected to remain in the real estate market, since the demand for almost
all kinds of real estate (houses, land, apartments) exceeds supply. Construction of new
apartment blocks in Riga is ongoing, and pre-war buildings undergo renovation. VAS State
Real Estate also keeps ensuring the continuity of the works associated with the buildings of
national significance.
3.3 Trade
Trade, compared to other services sectors, is a sector whose many segments are suitable for
development of more enhanced provision of remote services. Each wave of the pandemic
witnessed a considerable growth in online sales volumes, demonstrating people's adaptation
to the new realities. In 2020, the value added of trade edged down by 2.3%, including a
marginal decline in the fourth quarter, when a proportion of retail sales was not available
in person anymore. Cancellation of public events also reduced consumption needs, which
would normally be related to preparations for festive occasions. Thus, recent months saw a
substantial decrease in retail sales of non-food goods, particularly clothing and household
goods (except household electrical appliances in January).
During the second wave of the COVID-19 pandemic, mobility indicators of retail trade
remain low for a longer period than during the first wave. Short-term data show both a fall
in retail trade volumes in January and a low level of activity in the segment of first-time
registered motor vehicles in January and February, which in turn points to a drop in sales of
motor vehicles. Despite the availability of government support and its expansion in recent
months to help to stabilise the labour market situation and income level, consumer spending
behaviour is cautious. Sentiment of customers and retailers remains relatively pessimistic,
and together with the above indicators it generally suggests that the first quarter is expected
to record a decline in the sector's growth.

23
March 2021
3.4 Transportation
With freight transportation following a downward path and passenger transportation volumes
decreasing, the transport sector still witnesses decelerating growth. In 2020, the value added
of the transport sector decreased by 14.7%, and exports of transport services also edged
down.
The volume of cargoes loaded and unloaded at ports and that of freight transportation by rail
has already been contracting for a considerable time. The major factor behind this is a steep
fall in the volume of coal cargoes. This long-term trend relates to reorientation of Russian
transit flows to the local ports and the phasing out of fossil fuel elsewhere. Although the
record-high agricultural yields provided a positive contribution of grain cargoes in 2020, and
the contribution of wood cargoes was also positive at the end of the year, it could not offset
the deceleration in coal cargoes. The volume of cargoes loaded and unloaded at ports shrank
by 28.0%, while the turnover of rail freight – by 46.9%. The January data on port operation
suggest that similar development was also registered in early 2021.
The number of passengers transported by air decreased by 74.2% in 2020 due to the
material impact of the COVID-19 pandemic crisis on the air transport sector. Flights to
third countries were resumed on 17 March 2021, allowing the air transport sector to recover
slightly. However, with morbidity rates remaining high in Latvia and Europe alongside with
countries continuing the implementation of restrictions for the control of the virus spread,
it is unlikely that the air passenger flow will return to the pre-crisis level in the near term.
Since AS Air Baltic Corporation and VAS STARPTAUTISKĀ LIDOSTA "RĪGA" carried
out collective redundancies and reduced the aircraft fleet due to operational constraints, the
sector will need time to recover. The COVID-19 pandemic has also had a significant effect
on road transport, impeding logistics, delaying deliveries as well as disrupting supply chains.
This situation led to a contraction of freight turnover by road by 8.4% in 2020, with freight
turnover in international transport falling strongly. The demand for international freight
transportation will edge up in parallel with a gradual recovery of trade partners from the
crisis; however, it will also take time in this area. When assessing freight transportation by
road in a longer run, next steps of the Mobility Package I will play a major role. The EC
study1
concludes that the application of cabotage quotas and the requirement to return the
vehicle to the country of establishment on a regular basis (every eight weeks) can increase
emissions and have an adverse effect on the environment. However, in the event that the
current version of the Mobility Package I enters into force, it will reduce competitiveness
of Latvian freight transport by road. Overall, the transport sector will continue to weigh on
GDP dynamics also in 2021.
Chart 18
Ports
Railway
Road transport –60
–30
20
0
10
–10
–40
–20
–50
1 3 4 1
2019
2 3 4
2
2020
–60
–30
20
0
10
–10
–40
–20
–50
FREIGHT TURNOVER IN MAIN TYPES OF
FREIGHT TRAFFIC
(in tonne-kilometres; at ports – in tons; annual
)
changes; %
1
https://ec.europa.eu/transport/modes/road/news/2021-02-mobility-package-i-studies_en

24
March 2021
4. GDP ANALYSIS FROM THE DEMAND SIDE
4. GDPAnalysis from the Demand Side1
Domestic demand was negatively affected by national restrictions, income declines and
high uncertainty, all of which has constrained people in their consumption and investment
decisions. Nevertheless, businesses and consumers are minimising the negative effects
by adapting to the situation and by employing new digital or other solutions. The public
consumption dynamics are driven by the support measures implemented to mitigate the
impact of the Covid-19 pandemic crisis. Latvia's external demand was more resilient
compared to that of other European countries. Furthermore, the structure of Latvia's exports
was also more favourable and enjoyed more robust demand during the pandemic.
4.1 Domestic demand
Similar to the situation observed in spring 2020, at the beginning of the Covid-19 pandemic,
in the fourth quarter of 2020 consumption recorded the most notable decline. This
development was largely driven by the measures introduced mostly in the services sector to
contain the pandemic, inter alia restrictions on travel, cultural, sporting and other activities,
thus making spending on such services impossible. This time, however, the contraction
was much less pronounced than estimated based on the impact seen in spring. This means
that businesses and consumers have become more adapted to the situation and have created
new digital or other solutions to maintain their production output and consumption. While
such processes were projected, they have turned out to be more efficient and significant
than expected. In 2021, household consumer spending will be facilitated by one-off benefits
paid out to families with children, pensioners and persons with disabilities – or the so-called
"helicopter money" – an atypical solution to stimulate consumption and mitigate the uneven
impact on households caused by the crisis.
The crisis situation has had a negative and comprehensive impact on the consumer
confidence. However, compared to the crisis of 2008–2010, the assessment of the
households' financial situation is much more optimistic, while the economic situation and
forecasts are almost as negative. This leads to the conclusion that behaviour and confidence
were affected by this crisis more negatively than income. Nevertheless, there is substantial
evidence suggesting that the impact of the crisis was uneven; therefore, these confidence
indicators may be greatly polarised.
Chart 19
Imports of goods and services
Exports of goods and services
Changes in inventories
Public consumption
Gross fixed capital formation
Private consumption
GDP (%) –25
–20
–15
–10
–5
0
5
15
10
–25
–20
–15
–10
–5
0
5
15
10
1 3 4 1
2019
2 3 4
2
2020
GDPAND DEMAND SIDE COMPONENTS
( )
annual changes; at constant prices; percentage points
Investment activity was sluggish at the end of 2020 and throughout the year. Amid
heightened uncertainty, private sector investors were cautious, and part of investors
postponed their investment plans. Meanwhile, the decision to allocate additional funds
for the improvement of infrastructure as well as other types of support reinforced the
government investment. However, not all projects were brought to life.
Looking by type of investment, in the fourth quarter as well as in 2020 overall the
1
This chapter analyses GDP and demand components at constant prices, using seasonally and calendar adjusted data
(unless otherwise specified).

25
March 2021
most negative contribution came from transport equipment, whereas the most positive
contribution was made by other construction and production equipment. The category of
production equipment also includes computers and other ICT equipment which, amid the
rising popularity of remote work, is in high demand. Civil engineering performance suggests
growth and helps maintain the overall level of investment.
Chart 20
Gross fixed capital formation
Construction of buildings
Construction of engineering structures
Imports of capital goods 0
40
60
80
100
120
140
180
160
20
0
40
60
80
100
120
140
180
160
20
1 3 4 1
2019
2 3 4
2
2020
INVESTMENT
(2015 = 100; at constant prices)
EU financing will continue to play an important role in facilitating investment and
strengthening economic growth. Over the coming years, the economy will see significant
inflows of additional EU funds, including those available within the Rail Baltica project
and the EU Recovery and Resilience Facility (RRF). The estimated total costs of the Rail
Baltica project in Latvia amount to nearly 2 billion euro. However, due to delays in works,
the project deadline may be moved to 2030 (currently – 2026), thus increasing the risk of
higher total costs. Moreover, given that the 2021-2027 long-term EU budget is currently still
in its drafting stage, there is a lack of clarity regarding the overall flow of the project funds.
Nevertheless, the EU framework regulations governing the implementation of the RRF plan
have been approved, thus allowing for further drafting of the 1.65 billion euro investment
plan for the period until 2026. For the time being, Latvia has chosen to draft the plan
covering 70% of the potentially available financing, as the remaining available financing will
be calculated by the European Commission in August 2022, based on the GDP growth data.
The RRF provides an opportunity to facilitate investment inflows in the economy through
public support, without increasing the level of government debt.
Financial position of a household in the next
12 months
Financial position of a household in the previous
12 months
Economy's outlook for the next 12 months
Large purchases planned for the next 12 months
Consumer confidence
Chart 21
2019
III VI IX XII
2020 2021
III VI IX XII
–30
–25
–20
–15
–10
–5
0
5
–30
–25
–20
–15
–10
–5
0
5
CONSUMER CONFIDENCE AND
UNDERLYING FACTORS
(net responses; percentage points)
4.2 Government consumption
In the second half of 2020, the public consumption was further affected by the decisions
taken to mitigate the Covid-19 pandemic crisis to meet the liquidity needs of businesses and
help preserve household income. Moreover, since the beginning of 2021 the government
support to mitigate the crisis has increased significantly. Therefore, the budget deficit is
projected to be higher this year.
Following a rapid decline in the second quarter of 2020, the general government sector
tax revenue rose again in the second half of 2020. With the economic situation improving
in the third and fourth quarters, the tax revenue grew slightly year-on-year by 1.4% and
0.6% respectively. The data for January 2021 also suggest that, despite the strict restrictions

26
March 2021
imposed in various sectors, the tax revenue has not declined significantly compared to
January of the previous year, i.e., the pre-pandemic period, shrinking by a mere 3.3%.
However, since early 2021 it has been difficult to estimate the revenue from individual taxes
due to the fact that a significant share of tax revenue, i.e. 108.4 million euro or 13.9% of
total tax revenue in January, has been recorded in the single tax account.
Pursuant to the State Revenue Service data, the tax deadline extensions granted based on
the impact of the Covid-19 pandemic over the period from the start of the pandemic until
8 March 2021 reached a total of 209.4 million euro. Of the deadline extensions granted
in 2020, the largest share, i.e., 45.3%, were granted for the social security contributions,
followed by 32.5% extensions granted for VAT payments and 14.5% – for personal income
tax payments. With the easing of restrictions, the economy recovering and businesses
beginning to partly repay their taxes that had been subject to deadline extensions, this
support instrument is expected to be employed less in 2021.
Meanwhile, the Covid-19 pandemic crisis significantly affected the budget expenditure
already in the second quarter of 2020, and the impact continued into the second half of the
year as the expenditure grew by 8% year-on-year, with similar increases recorded for both
current and capital expenditure. In 2021, the government expenditure will also grow due
to decisions on additional support measures to mitigate the consequences of the Covid-19
pandemic crisis, in particular, social benefits, including one-off benefits paid out to parents
(500 euro per child), pensioners and persons with disabilities (200 euro), as well as health-
care related support and additional spending on infrastructure projects. Looking by sector,
the most comprehensive support is aimed at the health care sector. Meanwhile, support in the
form of subsidies is also intended for farmers and those working in the cultural and tourism
services and other sectors. Over the first three months of 2021, the amount of the working
capital grants paid out under the State Revenue Service programmes continued to increase.
By contrast, in early March the furlough benefits and wage subsidies as well as the rate of
increase in their applications began to decline.
In 2020, the general government budget deficit is estimated to be 5.3% of GDP. More
accurate information will be available after the Eurostat communication at the end of April.
Meanwhile, given the extensive new support measures implemented in 2021 to mitigate the
Covid-19 pandemic crisis, the budget deficit is projected to grow to 7.7% of GDP.
The general government debt valuation for 2021 has increased compared to its
2020 December forecast, with the debt level reaching 48.6% of GDP (2020 valuation –
44.7% of GDP). The debt development is largely shaped by the expansion of the support
measures associated with the Covid-19 pandemic, inter alia new support instruments
intended to preserve household income as well as significantly increased financing for the
health care sector and business grants.
4.3 Trade balance
The trade balance was also clearly affected by the epidemiological problems and restrictions.
Both in the crisis and during the recovery phase, Latvia's exports of goods was supported
by both Latvia's trade partners, which have seen their economies develop more successfully
against the backdrop of the rest of Europe, and the structure of products produced by Latvia's
exporters as they have enjoyed more resilient demand during the pandemic. In the second
half of 2020, Latvia's exports of goods even increased. However, the overall export volume
did not expand due to the difficulties in cross-border supply of services. Broad restrictions
on international travel have remained in place at the beginning of 2021, thus impeding
the recovery in services exports. Exports of goods will be facilitated by strong demand.
Moreover, its growth will largely hinge on the possibilities to increase the production and
sales volumes against the backdrop of the record-high levels reached in 2020.

27
March 2021
In the third quarter of 2020, trade in goods recovered swiftly and the best-performing
sectors, which had cushioned the drop during the crisis, continued their successful
development also in the fourth quarter despite the restrictions which, with varying levels of
strictness, remained in place both in Latvia and its trade partners. The crisis even brought
about additional demand in individual sectors, with exports of electrical machinery and
equipment accounting for the largest increases. The record-high grain harvest was met with
strong global demand and rapidly rising prices in the second half of 2020. Exports of wood
also benefited from higher demand and prices and significantly expanded at the end of the
year. However, the rise in exports of goods in the second half of 2020 did not offset the
stagnation in cross-border supply of services which saw no significant recovery from its
crisis low. Exports of travel services, which were hit most severely, only reached one fifth of
their previous year's level in the last quarter of 2020 and were even lower than in the second
quarter. Meanwhile, other business services as well as construction and computer services
managed to maintain their growth during the year of the pandemic. However, they were
unable to offset the contraction in the value of travel-related services.
Chart 22
Agricultural products
Beverages
Food products
Mineral products
Products of the chemical industry
Plastics and plastic products
Wood and wood products
Paper and paper products
Textiles
Basic metals and metal products
Machinery and mechanical appliances
Transport vehicles
Other goods
Total exports (%; right-hand scale)
–200
–100
–50
0
200
–150
50
100
XII
VI IX
2019 2020
III
150
–20
–10
–5
0
20
–15
5
10
15
XII
VI IX
III
EXPORTS OF GOODS AND GROUPS OF
EXPORT GOODS
(year-on-year; millions of euro)
With domestic demand recovering, in the second half of 2020 imports bounced back as the
decline in imports of intermediate goods moderated and imports of capital goods recorded
a year-on-year growth in the third quarter. Increases in imports of machinery and electrical
equipment, basic metals and products of the chemical industry suggested a recovery in the
supply of capital goods. At the end of the year, however, the rise in the value of exports of
goods was even more pronounced resulting in a positive goods and services trade balance in
the fourth quarter and throughout 2020.

28
March 2021
5. LABOUR MARKET, COSTS AND PRICES
5. Labour Market, Costs and Prices
Covid-19 takes hold, with containment measures still in place, and this presents challenges
to the labour market. The unemployment rate will follow an upward trend in early 2021,
although this year the availability of the government support will prevent an upswing in
unemployment. The most notable factors affecting the wage growth will be the raising of the
minimum wage, the increase in the wages of medical and teaching staff, as well as the
short-term Covid-19 related premiums for medical staff. February is likely to have been
the last of the coming months to record consumer price deflation. The increase in consumer
prices will be fuelled by the rising global prices of raw materials and the growing prices
of services caused by the pent-up demand and elevated costs. Although it is unlikely that
producer and importer price developments and inflation expectations of businesses and
consumers would trigger a steep rise in inflation, annual inflation might briefly approach the
rarely seen level of 3% in some periods of 2021.
With the economic situation deteriorating at the beginning of the year, the number of
unemployed persons registered with the SEA has also increased. Although the outlook of
employers regarding employment in the coming months has not deteriorated, it is, however,
still lagging behind its pre-crisis level. The recovery of the economic activity and the
availability of the government support will avert a further rise in unemployment until June.
Unemployment forecasts remain close to the December estimates (8.3% of the economically
active population in 2021; the forecast for December – 8.5%), while a steeper acceleration
of the economic activity will reduce the unemployment rate for 2022 to 7.3% at the end of
2021 (the forecast for December – 7.5%).
Chart 23
Share of jobseekers
Rate of registered unemployment 0
4
6
8
10
III VI IX XII
2019 2021
III VI IX
2
0
4
6
8
10
2
XII
2020
RATE OF REGISTERED UNEMPLOYMENT
AND THE SHARE OF JOBSEEKERS
(% of the economically active population)
In 2020, the wage growth has been much faster than projected. This is largely related
to structural changes. Employers have more frequently fired or put less qualified or less
experienced staff earning lower wages on downtime. This is evidenced by the wage
and salary fund statistics which only show a modest increase. This, in turn, implies that
the average labour income has statistically risen, although only a few are likely to have
experienced a wage increase. In 2021, the pick-up in wages will be mainly driven by the
raising of the minimum wage from 430 euro to 500 euro and the increase in the wages of
medical and teaching staff, as stipulated by laws and regulations. A temporary positive
contribution will also come from the pandemic related premiums for medical staff.
Meanwhile, no substantial pressure on wage rises is expected since labour supply will be
high. Financial resources of businesses will also be limited after the crisis, and this may
hinder wage growth in the sectors hit by the crisis. Due to the above-mentioned factors,
wages are expected to increase by 6.9% this year (the forecast for December – 5.3%). At the
same time, with the economic activity recovering and demand for skilled labour growing,
the average wage will rise by 5.7% in 2022 (the forecast for December – 5.1%).
In February, consumer price deflation was still driven by a decline in the prices of some
specific product groups (e.g. accommodation services and fuel), with three fourths of the
product prices growing faster than the total indicator. At the beginning of the year, producer

29
March 2021
price changes slightly exceeded zero, mostly due to energy and wood processing sectors.
The price dynamics of these two components reflect shifts in the global commodity markets.
Chart 24
Total economy
Private sector
Public sector 0
2
4
6
8
10
0
2
4
6
8
10
1 2 3 4 1 2 3 4
2020
2019
NOMINALAVERAGE MONTHLY GROSS
WAGE
( )
for full-time job; annual percentage changes
Chart 25
DECOMPOSITION OF HICP CHANGES
( ; by 163 ; % )
over 12 months product groups
90% of products
75% of products
50% of products
HICP
Fruit
Fuel
Accommodation services
III VI IX XII
2019 2020
III VI IX
–25
–20
–15
–10
–5
0
5
10
15
20
25
–25
–20
–15
–10
–5
0
5
10
15
20
25
XII
2021
The price of oil expressed in US dollars returned to its pre-pandemic level. Since the end
of 2020, the rise in oil prices has mainly mirrored hopes that vaccines would be effective in
curbing the pandemic. An upward trend in oil prices was also supported by the developments
in oil markets such as the oil production cuts maintained by OPEC+, the shrinking stocks of
oil products and the persistent relatively low number of US shale oil production platforms.
Although some analysts believe in a potential oil price surge even above 100 US dollars
per barrel, most investors, however, anticipate a moderate drop in oil prices in the medium
term, based on spare capacity to increase oil production in OPEC+ countries, the new US
administration's signals on the improvement of the relationship with Iran, as well as the
potential delay in containing the pandemic. The impact of higher oil prices on inflation in
Latvia was slightly offset by the appreciation of the euro against the US dollar. The rising
oil prices were reflected in fuel retail prices with a few weeks' lag. Moreover, heating and
natural gas tariffs started to move up slowly from record low levels at the turn of the year: if
the rise in oil prices turns out to be steady, tariffs will most likely continue to increase.
2022
2019
Chart 26
December 2019
September 2020
March 2021 30
45
50
55
60
65
2020 2021
35
40
30
45
50
55
60
65
35
40
OIL PRICE FORECAST
( ; annual average; US dollars per barrel)
Brent crude oil
Following a temporary decrease in autumn 2020, the global wood prices reached new
record highs, mainly reflecting a higher demand for wood due to the huge amount of house
refurbishing works during the Covid-19 pandemic. An increased demand for new housing
in the US substantially pushes up the demand for wood. At the same time, Canada (the
main exporter of wood to the US) stopped the very active felling of trees due to bark beetle

30
March 2021
damage. Investors believe that, although the prices of wood might remain unusually high in
the short run, the demand for wood should return to the normal level in the medium term.
The prices of wood may also decline due to the potential overproduction as producers are
currently trying to fully utilise capacities to reap maximum benefit from the high wood
prices.
Chart 27
95 octane petrol
Diesel fuel
0.9
1.0
1.1
1.2
1.3
1.4
0.8
0.9
1.0
1.1
1.2
1.3
1.4
0.8
07.03.2019
07.06.2019
07.09.2019
07.12.2019
07.03.2020
07.06.2020
07.09.2020
07.12.2020
07.03.2021
07.06.2021
07.09.2021
07.12.2021
AVERAGE RETAIL PRICE OF FUEL
( )
euro per litre
The global food prices have picked up over recent months. The prices of cereals increased
notably, reflecting both a strong demand from importing countries (China) and lower exports
from Russia (the export tax introduced to reduce the rise in food prices in the domestic
market) and Ukraine (due to a weaker harvest). Minor increases in the global prices of
dairy products (a high demand from China and Western European countries) and the prices
of meat (a strong demand at the time when the avian influenza virus is detected in some
European countries and swine fever is again observed in China) were also recorded. The
rising prices of sugar reflect an increase in the oil price due to which ethanol is increasingly
produced instead of sugar. The public demand for long life food products (e.g. buckwheat)
rose at the beginning of the Covid-19 pandemic, leading to a rise in their consumer prices,
and also at this point, the retail price of buckwheat is significantly higher than a year ago.
Producer prices of durable goods sold on the domestic market rose by 5% over the course
of 2020. However, due to the lower import prices consumer prices for industrial goods
increased only by less than half of per cent in 2020. Concerns that supply chain disruptions
will significantly push up the import and consumer prices for industrial goods have not
materialised so far. Producer price inflation expectations, although higher than at the
beginning of the pandemic, are still lagging behind their pre-pandemic level.
Following a decrease in the first months of the pandemic, the prices of services started to
pick up again in the second half of 2020. The prices of services are also expected to rise in
the coming months. This will be driven by both the demand and cost factors. Some services
were not available in the preceding months; therefore, the pent-up demand will reduce
the household savings and boost their consumption as soon as the Covid-19 pandemic
restrictions are eased. Moreover, the costs of several services per customer are higher than
before the pandemic, due to the social distancing rules and because the minimum wage
was raised significantly at the beginning of 2021. As a result of the interaction between the
demand and cost factors, several hairdressing salons and beauty parlours which reopened in
March have already increased their prices.
For some services which were not available, only price estimates were provided in the last
months (in some cases it was assumed that the price level remained unchanged). This means
that the increase in the minimum wage and the effect of the pent-up demand were not yet
reflected in the prices of, for example, hairdressing salons in February. Similarly, the prices
of transportation services by air do not yet capture the impact of the rising fuel prices. The
impact of these factors will show up in the consumer price statistics only when the easing of
the social distancing rules allows the service providers to work with greater capacity.

31
March 2021
Chart 28
CHANGES IN HICP BY COMPONENT
(annual changes; percentage points)
Other goods and services
Energy
Food
Inflation (annual percentage changes) –2
1
2
3
4
XII
VI IX
2019 2020
III
–1
0
–2
1
2
3
4
–1
0
VI IX
III XII
2021
The box analyses the impact of the consumption structure changes caused by the pandemic
on inflation.
BOX. DOES THE CONSUMPTION STRUCTURE CHANGES CAUSED BY
THE PANDEMIC AFFECT INFLATION?
The Covid-19 pandemic has significantly affected the spending habits of consumers and
changed the basket of the goods and services they buy on a day-to-day basis respectively.
Several services were limited and, in some months, even unavailable because of the
pandemic. Households also consumed less goods and services owing to precautionary
behavior. Such changes in consumption patterns are also reflected in the consumer price
weights in 20211
. The weight of processed food (e.g. bread and pastries) has increased,
while that of services, especially restaurant and cafe services, has decreased (see Charts 29
and 30).
Restaurants and cafes
Passenger transportation by bus
International flights
Accommodation services
Recreation abroad
Fresh vegetables
Cheese and cottage cheese
Pastries
Coffee
Bread
–1.0 –0.4
–0.6 –0.2 0.0 0.2 0.4
–0.8
Chart 29
CHANGES IN CONSUMER PRICE WEIGHTS
FOR INDIVIDUAL GOODS AND SERVICES
(2021; percentage points)*
0.6
* The chart shows the most pronounced changes in the weights of individual consumer prices in 2021 as compared to 2020.
Total
Chart 30
IMPACT OF THE CHANGE IN WEIGHTS
ON INFLATION
(January 2021; percentage points)*
0.0
0.1
0.2
0.5
0.3
0.4
0.6
0.0
0.1
0.2
0.5
0.3
0.4
0.6
Unprocessed
food
Processed
food
Energy Other
goods
Services
* The chart uses the consumer price data in accordance with the European Classification of Individual Consumption according toPurpose (ECOICOP5).
The inflation projection estimates are based on Latvijas Banka's Short-Term Inflation Projections (STIP) model (Latvijas Banka Working Paper 1/2020).
Such a dynamic shift in the goods and services basket has also somewhat affected the
headline inflation. This means that inflation has picked up since the weight of the goods
and services whose prices have been on the rise over the last year (e.g. the prices of bread)
1
The Eurostat recommendations stipulate that the estimates of HICP weights for 2021 should be based, as far as
possible, on a wider range of information on consumption expenditure for 2020. For more information, see "Guidance
on the Compilation of HICP Weights in Case of Large Changes in Consumer Expenditures".

32
March 2021
has increased and the weight of the goods and services whose prices follow a downward
trend (e.g. the prices of flights and recreation abroad) has decreased. The estimates
indicate that the services prices have been most affected by the change in weights as they
were 0.5 percentage point higher in January 2021 due to the shifting weights.
Looking ahead, our estimates suggest that overall the impact of the consumption structure
changes on the average inflation for 2021 will not be strong – a positive effect on inflation
of January will be largely offset in the coming months1
. It is expected that the Covid-19
restrictions will be eased and demand will recover in the second half of 2021. As a result,
some services will become more available and the prices of, for example, accommodation
services will rise somewhat. However, the impact of these services will not be severe as
they account for the smallest share in the consumption basket.
1
The exact impact will be known at the end of the year after the publication of the inflation data for December 2021.

33
March 2021
6. Conclusions and Forecasts
In 2020, GDP declined less than expected owing to successful containment of the pandemic,
monetary and government support, adaptability of consumers and businesses as well as
temporary factors unrelated to the pandemic, e.g. exceptional grain harvest and a steep rise
in the wood industry output.
In early 2021, GDP is expected to decrease, whereas in 2021 overall GDP growth may reach
3.3%, compared to the December 2020 forecast of 2.8%. Although the state of emergency
was extended, the government support provided to overcome the crisis was also increased.
With the infection rates declining only moderately, uncertainty remains high, encumbering
investment decisions and, together with the adverse impact of the pandemic on employment
and income, resulting in more cautious spending behaviour of consumers. At the same time,
due to restrictions, many services are still unavailable or cannot be remotely provided to
their full potential. Under such conditions, the level of savings will remain high in the first
half of 2021.
Assuming that vaccination will proceed in line with the plan1
, restrictions are expected
to be reduced considerably from the second half of 2021, improving both consumption
opportunities and consumer and business confidence. The fiscal measures supporting
household income and more active spending of the precautionary and forced savings, which
was impossible during the pandemic due to restrictions, will drive a rapid recovery of the
private consumption. This year, the rapid public consumption growth will be related to
the increased fiscal support for softening the crisis impact. Investment decisions will be
supported by the improving sentiment of economic agents. Moreover, the financing of the
Recovery and Resilience Facility will gradually become available. The expansion of exports
of goods and services is projected to be in line with external demand as it recovers gradually.
With external and – particularly – domestic demand improving, imports of goods and
services will also see significant growth, reflected in a negative foreign trade balance.
The rapid recovery is projected to remain resilient in the second half of the year and to
continue in 2022 with 6.5% GDP growth.
Chart 31
GDP
(annual changes; %; at constant prices; seasonally and
calendar adjusted data; 2021–2022: Latvijas Banka
forecast)
2019 2020 2021 2022
–10
–8
–4
–2
0
2
4
8
6
–6
2.0
–3.6
3.3
–10
–8
–4
–2
0
2
4
8
6
–6
6.5
In the first two months of 2021, the consumer price dynamics remained negative year-on-
year. However, February is likely to have been the last of the coming months to record
consumer price deflation. The projected inflation for 2021 is 1.8%, higher than the December
2020 projection of 1.1%. The projection was revised upwards mainly due to higher oil and
cereal prices. Following a period of deflation during the first two months of 2021, inflation
is expected to record robust growth, with the annual inflation reaching 3% in some months.
Consumer prices will also be supported by a rise in service prices on account of the pent-up
demand and elevated costs. Consumer price inflation is projected to reach 2.2% in 2022.
The short-term risks to the GDP and inflation forecasts are on the downside and mainly
hinge on the opportunities to contain the pandemic. If the vaccination does not proceed
1 See https://covid19.gov.lv/sites/default/files/2021-01/vmzin_p_050121_covid_vak.pdf.
6. CONCLUSIONS AND FORECASTS

Macroeconomic Developments Report. March 2021

Macroeconomic Developments Report. March 2021

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